Yahoo Tying Its Future Even More Closely To Alibaba Is Worrying

Jul.16.14 | About: Yahoo! Inc. (YHOO)

Summary

Yahoo’s efforts to hold on to the Alibaba lifeline are a signal that the company, at least for now, cannot think of something better to do.

While Yahoo says it's working towards monetizing its stake in Alibaba in the most tax efficient way it could take many years to execute such a strategy.

Ex-Alibaba, Yahoo is struggling to keep pace with the latest industry trends and the changing online atmosphere.

Yahoo! Inc. (NASDAQ:YHOO) hasn't been performing up to expectations for some time now. The company reported 2Q14 operating EPS of $0.37, slightly below consensus estimates of $0.38. The only exciting thing about Yahoo at the moment is its investment in Alibaba, as the stock has been trading mostly as a proxy for the upside potential in Alibaba. However, Alibaba will soon go public and in a life beyond Alibaba, Yahoo urgently needs to monetize mobile traffic, as much of its growth has been in apps that Yahoo doesn't monetize such as Stocks and Weather. While the company is taking initiatives in an effort to drive growth, more aggressive measures are required, as its efforts are yet to achieve any significant results.

Alibaba IPO

Since Marissa Mayer has taken charge, the company has bought or made investments in a large number of firms. One of these firms is the Chinese owned website Alibaba for which the company paid $1 billion in 2005 and in turn owns approximately 24% of the site's shares. The company is reaping huge returns from the website at the moment as its valuation has skyrocketed in the past three years. Moreover, the Chinese company is expected to add a tremendous value to Yahoo's balance sheet depending upon its momentum leading up to its IPO.

The company recently announced amendments to its agreement with Alibaba and will now keep a bigger than expected chunk of its stake in the Chinese e-commerce company. Under the new agreement Yahoo now must sell 140 million Alibaba shares in the IPO, lower than 208 million required earlier. This is positive for Yahoo as it allows the company to hold on to its interest longer, at a minimum delaying taxes, and allows it to hold a bigger chunk of a company it believes will continue to appreciate in value. Yahoo will own approx. 18% of Alibaba post IPO compared to 14.5% had it sold the previously agreed higher number of shares. Yahoo currently owns 24% of Alibaba.

Yahoo has said that it will use half of the after-tax proceeds from its share sale in Alibaba IPO to buy back shares. If we value IPO anywhere near $130-$150 billion this could lower the share count by 7-9%. Again this announcement to use half of the proceeds to buy back shares is positive for Yahoo.

As far as the remaining shares are concerned, the company says that it is working toward monetizing the stock in the most tax efficient way possible. While holding on to shares post IPO to monetize in a tax efficient way could be material for Yahoo in the long term, this strategy is not without its risks. The downside of this strategy is that it could take many years to execute a tax efficient structure. Moreover, at this time, there is no guarantee that the company will actually be able to monetize the shares in a tax efficient manner.

Yahoo is hoping that Alibaba's share price will fare well post IPO but if that is not the case, as we have seen with Facebook (NASDAQ:FB), Yahoo may rue not selling early. So as I said earlier while strategy could be material for Yahoo in the long term, it is not without its risks. It is also an admission on the part of the company that it is not bold enough to think of something better to do.

Difficult Transition to Mobile

With the online trend shifting from desktop to mobile, the company's desktop ecosystem reported mixed results for the traffic to Yahoo Sites. The company is reporting almost no growth in its quarterly advertising revenues for more than a year, primarily because of declining traffic to sites and a shift of brand and banner advertisers towards mobile and social media.

Although the situation is getting better now with the company reporting only a 4% decline in revenues as compared to the double digit decline during the first half of the last year and mid single digit declines reported in the second half. Going forward, as every internet company is focused on attaining growth from mobile, so is Yahoo and has therefore made it a core part of its ongoing strategy. The company's mobile traffic has increased by more than 100% over the last two years and the trend is expected to continue.

Although the company managed to increase its mobile traffic in the last few quarters, Yahoo is one of the companies that are going to be hit the hardest from desktop to mobile transition. The company's revenues are primarily driven by the core banner and display advertisements on its sites, such as Yahoo Finance and Fantasy Sports, which are tough to replicate on mobile from both inventory and revenue perspective as less space would generate less revenues.

I believe for Yahoo to make a successful transition to mobile, it needs to develop new apps and monetize them. Some of the company's recent launches, such as weather app and news digest, have high quality and the ability to engage users. These apps have been successful and are getting good reviews and increasing traffic but the company isn't able to monetize them yet due to lack of advertisements. Moreover, these apps were able to deliver strong growth due to its partnership with Apple (NASDAQ:AAPL) and it now appears that the company is no longer supplying weather information to Apple as Apple has made arrangements directly with The Weather Channel to provide it with data.

Has Not Been Able To Win Apple Yet

Going forward, monetization would be the key to survive in mobile environment and it appears, as of now, the company is entirely focused on traffic and user growth and ability to monetize the improved mobile traffic is not a top priority. Although the company's strategy is not entirely flawed but growth without any revenue generating ability is not something to get excited about either. While Yahoo wants to be big in mobile, the company is not innovating enough and is still without any go to product, device, or OS. The company depends on other names like Google (GOOG, GOOGL) and Apple. While Yahoo has hoped to tighten its relationship with Apple by making Yahoo the primary search engine used throughout iOS and has even improved its technology in this regard, the company as of now does not seem to be in a position to become a default search engine in iOS any time soon. Moreover, with its strategy to work together with other companies Yahoo will not be able to carve out its own niche.

Steps In The Right Direction But Are They Enough?

The company has launched many new platforms recently to enhance its ad buying experience. In order to achieve simplicity, Yahoo has put all of its advertising under one head, Yahoo Ad manager, so that advertisers can easily shop inventory from all the platforms from one place. Moreover, the company has also launched Yahoo Gemini to facilitate advertisers to buy across search and native advertising.

The company has also rolled out sponsored posts on Tumblr, Stream ads for video and Yahoo image ads in order to monetize through advertising. The company's efforts to increase its advertising revenues are expected to yield positive results and are moves in the right direction. However, the long-term monetary success of these initiatives remains to be seen.

Conclusion

All the excitement that we have seen in the shares over the last year was primarily because of Yahoo's investment in Alibaba. Yahoo's shares are down 15.5% YTD and I don't think the company's fortunes are expected to reverse anytime soon, not unless it introduces a revolutionary product. I expect the underperformance to continue, once the company starts selling its stake in Alibaba. Yahoo is struggling to keep pace with the latest industry trends and the changing online atmosphere. The company's revenues are primarily driven by desktop and the recent shift towards mobile by the users, and in turn advertisers, is hampering the company's future revenues.

Lately the company has been benefiting from its investment in the Chinese e-commerce giant Alibaba but things will change later this year when Alibaba goes public. Mayer has a lot of work to do after the missteps in commerce, search, email, online auctions etc. However, at least I don't see Yahoo emerging from a state of stability back into a growth company anytime soon. The company's efforts to hold on to the Alibaba lifeline are a signal that the company, at least for now, cannot think of something better to do.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.